The biotechnology industry presents a high-stakes investment landscape, where outcomes for investors are often binary and the line between success and failure is remarkably thin.
In the best-case scenario, a biotech company’s products successfully pass through rigorous clinical trials, gain commercial viability and achieve significant market sales. This success can lead to the company’s stock price soaring, resulting in substantial returns for investors who backed the right horse.
However, the worst-case scenario is starkly different. Regulatory hurdles, a failure in clinical trials or an inability to achieve commercial success can lead to significant financial losses and a total wipeout of an investor’s capital.
“There is a high risk of failure for biotech companies, as innovations must undergo years of clinical trials and a failure can destroy the equity in a company,” says Adam Grossman, global equity chief investment officer at RiverFront Investment Group. “Therefore, returns in the space are widely dispersed, so picking individual biotech companies that will win is very difficult and risky.”
Considering that about 90% of clinical drug development fails, investing in individual biotech stocks often resembles more of a high-risk bet than a long-term growth opportunity.
“Given biotechnology firms have limited revenues, if any, from commercialized products, a lot of their market performance is based on the development of investigational treatments,” says Arelis Agosto, senior health care analyst at Global X ETFs. “From there, only an estimated 9.6% of drugs that enter phase 1 clinical testing are expected to reach the market, though biotechnology treatments that are approved can have remarkable returns.”
In such a high-risk industry, biotech exchange-traded funds, or ETFs, emerge as a safer alternative. These funds allow investors to benefit from the growth potential of the overall biotech industry while mitigating company-specific risks.
By investing in a diversified portfolio of biotech firms, ETF investors increase their chances of capturing the winners that will eventually lead the industry. These successful companies, though few, can significantly impact the ETF’s overall performance, potentially offsetting the losses from the many that don’t make it.
Here are seven of the best biotech ETFs to buy in 2023:
|iShares Biotechnology ETF (ticker: IBB)
|Global X Genomics & Biotechnology ETF (GNOM)
|WisdomTree BioRevolution Fund (WDNA)
|Invesco Nasdaq Biotechnology ETF (IBBQ)
|SPDR S&P Biotech ETF (XBI)
|VanEck Biotech ETF (BBH)
|Direxion Daily S&P Biotech Bull 3X Shares (LABU)
iShares Biotechnology ETF (IBB)
“Unless an investor has a really high risk tolerance and a strong belief that they have an edge in deciding what drugs will make it through trials, we would recommend an investor use the diversification inherent in an ETF to invest in the biotech space,” Grossman says. A popular option is IBB, which has attracted more than $6.4 billion in assets under management, or AUM. The fund charges a 0.45% expense ratio, meaning you’ll pay $45 annually for every $10,000 invested.
This ETF tracks the NYSE Biotechnology Index, which currently holds 262 US-listed biotech companies. “IBB is market-cap weighted, which means larger, and presumably better-capitalized, companies represent a larger proportion,” Grossman says. “Our belief is that larger companies will be able to fund themselves through higher interest rate periods.”
Global X Genomics & Biotechnology ETF (GNOM)
“Instead of being beholden to the binary nature of biotech events, investing in a broader pool of biotech firms helps hedge risk for negative events while still having significant exposure to long-term structural shifts in the health care industry,” Agosto says. For biotech investing, Global X offers GNOM, which also provides exposure to the field of genomics.
“GNOM specifically only includes firms that fall into one of our four key segments for genomics biotech, meaning at least 50% of each firm’s existing or expected revenue comes from either gene editing, genomic sequencing, genetic medicines and therapies, or computational genomics and genetics diagnostics,” Agosto says. The ETF has 41 holdings and charges a 0.5% expense ratio.
WisdomTree BioRevolution Fund (WDNA)
With a 0.45% expense ratio, WDNA charges the same fees as IBB. The ETF tracks the WisdomTree BioRevolution Index, which – unlike the index tracked by IBB – does not restrict itself to only US-listed biotech firms. Around 80% of the ETF’s portfolio is held in US biotech firms, while the remaining 20% consists of holdings from countries like Germany, Denmark and Switzerland.
A way investors can fit WDNA into their portfolio is via a “core and explore” approach, which means pairing it with a low-cost index fund. “The ETF also can be used to complement core portfolios with innovative megatrends in the biotech space and satisfies demand for genetics and biotechnology investments with strong growth characteristics,” says Jeremy Schwartz, global chief investment officer at WisdomTree.
Invesco Nasdaq Biotechnology ETF (IBBQ)
“Robust merger and acquisition activity, the ongoing commercialization of COVID-19 vaccines and treatments, and the potential for high-value artificial intelligence-enabled biotech platforms could serve as a catalyst for biotech stocks in the near- to medium-term,” says Rene Reyna, head of thematic and specialty product strategy at Invesco. The firm’s ETF offering for biotech is IBBQ.
“IBBQ tracks the Nasdaq Biotechnology Index, a nearly three-decades-old index methodology that remains straightforward, transparent and befitting of a true industry benchmark,” Reyna says. With a low 0.8% 30-day SEC yield, IBBQ is also fairly tax-efficient if held in a regular brokerage account. The ETF is also the cheapest option on this list, with its very competitive 0.19% expense ratio.
SPDR S&P Biotech ETF (XBI)
Biotech investors looking to dial up risk in exchange for potentially higher returns can use XBI to do so while remaining diversified. Unlike the previous ETFs that are market-cap weighted, XBI’s benchmark, the S&P Biotechnology Select Industry Index, is equally weighted. As a result, the ETF’s portfolio holds a significantly higher concentration of small- and mid-cap biotech firms.
Historically, XBI has provided a fairly competitive return, albeit at the cost of high risk. From January 2007 to Oct. 31, 2023, the ETF has returned an annualized 9.4% versus 8.7% for the SPDR S&P 500 ETF Trust (SPY), but with significantly higher volatility and drawdowns, making it a bit of a roller-coaster ride for investors. In terms of fees, the ETF charges a competitive 0.35% expense ratio.
Investors looking to target the largest and most liquid US-listed biotech stocks can do so via BBH, which tracks the MVIS US Listed Biotech 25 Index. Unlike XBI, BBH is market-cap weighted instead of equal-weighted. Notable top holdings include Amgen Inc. (AMGN), Gilead Sciences Inc. (GILD), Vertex Pharmaceuticals Inc. (VRTX) and Regeneron Pharmaceuticals Inc. (REGN).
BBH is ideal for investors looking for exposure to large-cap stocks, given that its holdings have a weighted average market cap of $57 billion. With a beta of 0.8, this ETF is slightly less volatile than the S&P 500. However, it has been a star performer, recording a 12.9% annualized return since its inception in December 2011. BBH charges a 0.35% expense ratio.
Direxion Daily S&P Biotech Bull 3X Shares (LABU)
Short-term traders looking to speculate in the biotech industry can still find some useful ETFs for their needs. A great example is LABU, which is a leveraged ETF. This ETF employs derivatives to target a daily return three times that of the S&P Biotechnology Select Industry Index. If the index rises by 1%, LABU will gain 3%. If the index falls by 1%, LABU will drop 3%.
LABU is intended for short-term, daily holds. Longer holding periods can result in unpredictable returns as the leverage can cause returns and losses to compound dramatically. The ETF also charges a high 1.01% expense ratio. For traders looking to short the biotech industry, Direxion also offers the Direxion Daily S&P Biotech Bear 3X Shares (THE COMICS), which provides daily three times inverse exposure.